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Why Tech Stocks Hate Higher Interest Rates


This article first appeared in Morning Brief. Get the Morning Summary delivered directly to your inbox Monday through Friday by 6:30 a.m. ET. Ordered

Tuesday, January 31, 2023

Today’s news is from Julie Hyman, presenter and reporter at Yahoo Finance. Follow Julie on Twitter @juleshyman. Read this and more market news on the go with Yahoo Finance App.

It’s a chorus we’ve heard at Yahoo Finance for months: tech stocks can’t turn around until the Federal Reserve stops raising interest rates.

Or at least until investors believe the Fed will stop soon.

Nasdaq has bounced this year, as investors expect the central bank’s “pivot” away from higher interest rates and toward a pause or cut. That prediction is part of the reason why the above output 10-year treasury bond benchmark has dropped from a high of 4.24% in late October to around 3.5% today.

It’s also part of the reason why tech stocks bounced back.

So why did rising interest rates cause such a big problem for tech stocks in the first place?

In general, technology companies are generally growth companies.

To fuel that growth, they rely in part on borrowing money, regardless of whether companies use the money to hire software engineers, produce streaming shows, or make smartphones. or not. When interest rates are low, borrow more money for more initiative and growth, growth, growth is cheaper.

At the same time, investors who want high returns are encouraged to invest in growth stocks when rates are low.

“Logically, tech stocks are fundamental long-term assets,” said Steve Sosnick, Chief Strategist at Interactive Brokers. Throughout the 2010s, tech stocks were certainly seen as a more attractive investment than depositing money in low-risk, low-yielding government debt. (Programming Notes: Sosnick will join Yahoo Finance Direct at 9 a.m. ET today.)

And profits follow. Nasdaq 100 — an index of the biggest tech stocks — rallied nearly 1,500% between the previous low of the major bear market on November 20, 2008 and the most recent high on November 19, 2021. The S&P 500, an index that is larger than a diversified basket of stocks, rallied 609% during the rally from March 9, 2009 to January 3, 2022.

The pandemic and the resulting inflation from fiscal stimulus and congested supply chains prompted the Fed to raise interest rates, upending the investment story of the last decade. In 2022, the Nasdaq 100 fell 32%, marking its worst annual performance since the financial crisis.

Jefferies analyst Brent Thill examined the link between interest rates and software stocks, specifically the one he mentioned.

Thill found a clear positive correlation between ratios and shares of energy and a negative correlation between ratios and shares of software companies. In other words, a low ratio is good for technology and a higher ratio is good for energy. That’s exactly how 2022 plays out for investors.

This chart shows what investors discovered in 2022 — higher ratios are bad for tech stocks and good for energy stocks.  (Source: Jefferies)

This chart shows what investors discovered in 2022 – higher interest rates are bad for tech stocks and good for energy stocks. (Source: Jefferies)

Paul Meeks, veteran technology investor and portfolio manager at Independent Solutions Wealth Management, said: “I think the real issue here is that higher interest rates have to be discounted in the short term. cash flow models used to value tech and growth stocks.” “If interest rates are high and continue higher, valuations are unlikely to expand significantly even if fundamentals improve.”

Meeks also notes another phenomenon that accompanies low interest rates: private market valuations skyrocket as investors pour money into startups. This has also now been reversed.

“Higher rates discourage the U.S. engine of innovation because they will continue to stifle venture capital, private equity, and credit investment,” Meeks argues.

This week, tech giants including Amazon (AMZN), Alphabet (GOOGLE) and apple (AAPL) is due to quarterly results.

Apple CEO Tim Cook listens to U.S. President Joe Biden speak about his economic plan at the TSMC Semiconductor Manufacturing Facility in Phoenix, Arizona, on December 6, 2022. (Photo by Brendan SMIALOWSKI / AFP) (Photo by BRENDAN SMIALOWSKI/AFP via Getty Images )

Apple CEO Tim Cook listens to US President Joe Biden speak about his economic plan at the TSMC Semiconductor Manufacturing Facility in Phoenix, Arizona, on December 6, 2022. (Photo by BRENDAN SMIALOWSKI/AFP via Getty Images)

On Tesla (TSLA) on last week’s earnings call, CEO Elon Musk highlighted the effect on his vehicle’s affordability on higher prices, saying that “a rise in interest rates alone [effectively] raised the price of our cars in the US by almost 10%.”

Investors will certainly be looking for these companies’ views on how interest rates have impacted their future growth plans.

Although with Amazon and Alphabet announced job cuts in the tens of thousandsInvestors certainly have an idea.

What to watch today

Economy

  • 8:30 a.m. ET: Employment cost indexQ4 (1.1% expected, 1.2% last quarter)

  • 9:00 a.m. ET: Housing Price Index FHFANovember (-0.5% expected, 0.0% last month)

  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Compositemonth-on-month, November (-0.65% expected, -0.52% last month)

  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Compositeyearly, November (6.70% expected, 8.64% last month)

  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller US National Home Price IndexNovember (9.24% in the previous month)

  • 9:45 a.m. ET: MNI’s Chicago PMIJanuary (45.1 expected, 44.9 last month, revised to 45.1)

  • 10:00 a.m. ET: Conference Board Consumer ConfidenceJanuary (109.0 expected, 108.3 last month)

  • 10:00 a.m. ET: Current Situation of the Conference BoardJanuary (147.2 in the previous month)

  • 10:00 a.m. ET: Expectations of the General AssemblyJanuary (82.4 in the previous month)

income

  • Advanced micro-devices (AMD), Amgen (AMGN), Boston Attributes (BSX), caterpillars (CAT), ExxonMobil (XOM), common engine (GM), Juniper Network (JNPR), Petrol Marathon (MPC), match group (MTCH ONLY), McDonald’s (MCD), Mondelez International (MDLZ), NVR (NVR), Pfizer (PFE), Philippians 66 (psx), Pitney bowes (PBI), take a shot (SNAP), Sysco (SYY), ups (ups)

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